Civil servant 'contractor' staff to be paid as employees after six months in crackdown on tax avoidance

Civil servants working on contracts of more than six months or earning more than £220 a day will be paid as employees as part of efforts to stamp out tax avoidance in government departments.

The new rules, which affect contractors who earn more than £60,000 a year from the Government, have been set out in internal memos sent within HM Treasury and the Department for Business, Innovation and Skills.

The Professional Contractors Group (PCG), which obtained the leaked documents, warned it 'declared outright war' on freelancers and contractors, making this sort of working 'impossible' in the public sector.

Tax dodge: Officials say the practice of allowing officials to be paid through a personal company has become widespread

Officials have rushed in the new rules, which come into force in mid-September, after it was revealed in February that Ed Lester, head of the Student Loans Company, was being paid as a contractor with wages paid into his 'company'. The set-up was estimated to have saved the £160,000-a-year chief executive around £40,000.

An investigation found 2,000 civil servants were being paid this way.

Even beyond the public sector, the numbers of employees setting themselves up as companies has flourished in recent years, especially in the City in high-paid industries such as IT and banking.

Controversy: former Student Loans Company boss Ed Lester

Staff set themselves up as 'personal service companies' despite working 9 to 5 in the same job for several years. It drastically reduces the tax paid as the companies avoid national insurance and income tax, which can be as high as 50 per cent, and instead incur corporation tax, which the government cut this year from 21 per cent 20 per cent.

Rules set up a decade ago by the last government, known as IR35, are supposed to stop the system being abused but HM Revenue & Customs has only been enforcing it in a handful of cases each year.

HMRC chief executive Lin Homer this week told a Commons public accounts committee that the annual rate of IR35 enforcements, currently just 24, would rise '10-fold'.

It was also revealed this week that at least 300 BBC actors, presenters and musicians are paid as companies, including only those paid more than £50,000 a year.

Many presenters, including Fiona Bruce and BBC News 24 newsreader Joanna Gosling, are paid this way. Others set up as companies for payment include DJ Chris Evans and Top Gear presenter Jeremy Clarkson.

But the PCG warns the draconian new rules for the civil service would be 'damaging'.

John Brazier, MD of PCG, said: 'The harsh reality of this move will be to remove public sector access to freelance expertise and bluntly threatens to destabilise many Government Departments.

'This has gone a way beyond Ed Lester the head of the Student Loans Company who was clearly a case of false self employment; this is now attacking legitimate contractors who have done nothing wrong and are taking the brunt of a panic stricken Government and an HMRC who have launched a witch hunt.

'These people are essential to delivering vital public services and they are being treated in a scandalous way. The repercussions for operation of Government are potentially catastrophic.'

The PCG predicts thousands of experts engaged on short-term project work will be forced out, leaving bodies like the NHS and the Ministry of Defence 'without access to vital resources such as IT contractors and healthcare professionals'.

Those in the private sector, where as many as 500,000 people are set up as companies could also face greater scrutiny.

The detail of the 2012 Budget in spring suggested the rules of IR35 would be applied more vigorously. The Treasury and HMRC are in the throes of a consultation which ends on 16 August.

It could see interim managers - those who step in at a senior level in companies at short notice - being forced to pay income tax and national insurance.

Those operating in the sector say it will be a blow to the economy. 'Interims do a vital job stepping in at short notice to replace CEOs and other directors, often in crisis or turnaround situations,' said Doug Baird, managing director of Interim Partners. 'Interim managers take on projects that just can’t be dealt with properly by permanent staff.'

He added: 'Reducing the overall number of interims would hurt UK plc: it could seriously restrict the number of quality interim staff available to the UK’s public and private sectors. That is not in the interest of the public or private sectors.'

However, there has been a surge of support from Britons, feeling the ill-effects of austerity, for the government to crackdown on tax avoidance. The revelations about the tax affairs of comedian Jimmy Carr, in particular, sparked widespread public revulsion. Carr apologised for tucking away £3.3million a year in the Jersey-based K2 scheme.